Real Options and the Cross‐Section of Expected Stock Returns

19 Pages Posted: 13 Mar 2014

See all articles by Graeme Guthrie

Graeme Guthrie

Victoria University of Wellington - School of Economics & Finance

Multiple version iconThere are 2 versions of this paper

Date Written: April 2014

Abstract

This paper surveys the theoretical literature investigating the effect of firms’ investment flexibility on the cross‐section of expected stock returns. Real options analysis derives firms’ value‐maximizing investment policies as functions of exogenous fundamental drivers of profitability and calculates firms’ market values as functions of the same variables. These functions yield the relationship between expected stock returns and firm fundamentals. Several plausible explanations for the value premium – the high average stock returns earned by firms with high book‐to‐market ratios – emerge from this literature.

Keywords: Expected stock returns, Real options, Value premium

Suggested Citation

Guthrie, Graeme, Real Options and the Cross‐Section of Expected Stock Returns (April 2014). Journal of Economic Surveys, Vol. 28, Issue 2, pp. 265-283, 2014. Available at SSRN: https://ssrn.com/abstract=2408826 or http://dx.doi.org/10.1111/joes.12011

Graeme Guthrie (Contact Author)

Victoria University of Wellington - School of Economics & Finance ( email )

P.O. Box 600
Wellington 6140
New Zealand
64 4 463 5763 (Phone)

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